FIN 48: Accounting and Auditing Implications

In June 2006, the FASB released FASB Interpretation 48 (FTN 48), Accounting for Uncertainty in Income Taxes. FIN 48 amends Statement of Financial Accounting Standards (SFAS) 109 and specifies the accounting and reporting requirements for the uncertainty in tax positions an entity may take. The accounting and reporting requirements of FIN 48 involve a two-step process that may result in a larger income tax liability, a smaller deferred tax asset, or a smaller income tax refund. The requirements are difficult to understand and might have a significant impact on audited financial statements for large and small organizations.

The FASB provides the following reason for issuing FTN 48: "The diversity in practice (regarding uncertain tax positions) has resulted in noncomparability in reporting income tax assets and liabilities." FTN 48 was created primarily as a mechanism to provide greater transparency for uncertain tax positions in order to reform financial reporting of tax issues (S.E. Seigel, "There's a FTN in the Water," Vital Speeches of the Day. Metropolitan Club. New York, January 19, 2007.). As a result, FIN 48 has the potential to significantly impact financial statement reporting and disclosures, as well as financial statement audits.

The following summary of the recognition and measurement changes required by FIN 48 also includes practical examples of common tax positions that may result in uncertainty in income tax accounting, as well as common audit-related issues.

FIN 48 Requirements

FIN 48 requires any entity subject to income tax to apply a two-step analysis to uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006, for all public entities. The FASB decided to defer the effective date of FIN 48 for all nonpublic entities, including not-for-profits, to fiscal years beginning after December 15, 2007.

The first step in FIN 48 is to apply a recognition threshold to determine whether an uncertain tax position should be recognized within an entity's financial statements. If the threshold is met, an entity must then apply the second step, which is a measurement process to determine the amount of the uncertain tax position to be reported in company financial statements.

Recognition of uncertain tax positions. A tax position is a position taken by an entity in a prior or future tax return that is used when determining current income taxes, deferred income tax assets, or deferred income tax liabilities for annual and interim accounting periods. A tax position may cause a reduction in taxes payable, a transfer of current taxes payable to future years, or a change in how deferred tax assets are realized. Examples of tax positions noted in FTN 48 include classifying a transaction, entity, or other position as tax exempt; allocating or shifting income between jurisdictions; excluding taxable income from the tax return; and not filing a required tax return.

An entity should initially recognize the impact of an uncertain tax position in the financial statements if it is "more likely than not" (a likelihood of more than 50%) that a tax position taken by an entity will be sustained if examined using the technical merits of the position taken. The FIN 48 recognition threshold is based on the following assumptions: 1) The position taken by the entity will be examined by the appropriate taxing authority with full knowledge of all relevant facts; 2) the tax position will be evaluated without considering the impact of other tax positions; and 3) all authorities of tax law sources are used when considering the technical merits of the position, including widely understood past practices and precedents of the taxing authority related to the entity or similar entities.

Measurement of uncertain tax positions. If a tax position meets the recognition threshold, the second component of FLN 48 requires the position be measured for reporting in the financial statements. …

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